Archives: 04/2018

Dallas Fed: High And Rising Public Debt Is Associated With Slower Growth

Yesterday I was on a panel at Heritage looking at a Swiss-style debt brake and whether it was appropriate for the US.

US federal debt is now at its highest level as a proportion of GDP since 1950. Even prior to the recent tax cuts and budget-cap busting omnibus spending deal, debt was forecast to rise to 150 percent of GDP over the next three decades, primarily due to an aging population interacting with existing entitlement promises. Next week the Congressional Budget Office will publish its economic and fiscal outlook, which will show much higher deficits over the coming years following recent policy changes, and hence an even worse baseline of debt to ride into this fiscal headwind. Analysts expect the annual deficit could rise to around 5.3 percent of GDP in the next year or so.

Why does this matter from an economic perspective?

There are good economic reasons why we should desire a lower long-term debt-to-GDP ratio. For starters, a lower debt burden is insurance against the kind of “earthquake” debt crisis that John Cochrane and his Hoover Institution colleagues wrote about in the Washington Post last week. There are also obviously significant intergenerational consequences for taxpayers stemming from continually kicking the can down the road with ever-rising accumulated debt, with rising debt interest payments taking up a much higher proportion of government spending.

But a new Dallas Fed Economic Letter builds on previous research suggesting potentially the most damaging consequence: a rising debt trajectory seems to be associated with slower economic growth.

Back in the early part of this decade there was a huge debate about this. Ken Rogoff and Carmen Reinhart published a paper suggesting that growth across countries tended to slow substantially when government debt exceeded 90 percent of GDP. This “threshold effect” was taken by some commentators and politicians as gospel, but economists were more skeptical of thinking 90 percent represented a magical threshold beyond which disaster would strike. Then mistakes were found in the Reinhart-Rogoff work, and that hook was used to discredit the idea that there was a negative transmission mechanism between high debt and low growth at all.

This was an overreaction. Reinhart and Rogoff were not the only ones to find such an association. In fact, there was a lot of evidence out there that high debts were associated with slower growth. Stephen Cecchetti, M. S. Mohanty, and Fabrizio Zampolli identified a debt-to-GDP threshold of about 85 percent as a point beyond which growth tends to slow. Even Thomas Herndon, Michael Ash, and Robert Pollin, who replicated Reinhart and Rogoff’s work correcting for the errors, found that, on average, growth was 1 percentage point per year lower when government debt exceeded 90 percent of GDP than when debt levels were between 60 and 90 percent.

That’s what makes the new Dallas Fed note so interesting. They acknowledge, in line with basic intuition, that “the debt–growth relationship is complex, varying across countries and affected by global factors.” They also highlight the problem of disentangling the two-way causality between the two, and the possibility of discontinuities. Nevertheless, looking at a panel of advanced and emerging economies they conclude:

persistent accumulation of public debt over long periods is associated with a lower level of economic activity. Moreover, the evidence suggests that debt trajectory can have more important consequences for economic growth than the level of debt to gross domestic product (GDP).

Although there is no universally applicable threshold beyond which growth slows, countries with “rising debt-to-GDP ratios exceeding 60 percent tend to have lower real output growth rates.” What’s more, persistent accumulations of debt are associated with worse long-run growth outcomes:

These estimates are all negative and in the range of -5.7 to -9.4 percent, suggesting that a persistent accumulation in the debt-to-GDP ratio at an annual pace of 3 percent is eventually associated with annual GDP growth outcomes that are 0.2 to 0.3 percentage points lower on average.

Though the authors are careful to point out that this does not prove causality, the study does present evidence that if there is a transmission mechanism from high debt to low growth, the key to overcoming it is credible commitments and action to ensure debt increases are temporary phenomena. For the US federal government, rising debt looks a permanent reality right now as far as the eye can see.

For more on how fiscal rules could help play a part in changing this, read here.

And here’s the full discussion at Heritage from yesterday.

Bootleggers, Baptists, and Gun Control

In the May/June 1983 issue of Regulation, economist Bruce Yandle outlined a theory of regulation he referred to as “bootleggers and Baptists.” Using the example of laws forcing bars to close on Sundays, Yandle explains how well-intentioned Baptists worried about the “dangers” of alcohol and self-interested bootleggers hoping to profit when bars are closed both support the law for fundamentally different reasons.

While public discourse over regulation frequently identifies the “Baptists,” the role of “bootleggers” is often ignored. For example, a recent New York Times article discussing the Gun Control Act of 1968 overlooks the influence of U.S. gun manufacturers. The article describes the Act as a response to the assassinations of Martin Luther King Jr. and Robert F. Kennedy, which motivated President Lyndon Johnson to call for gun control legislation.

While the assassinations did propel the gun control movement, the Gun Control Act was also a chapter in a long running battle between U.S. gun manufacturers and importers of foreign firearms. In the fall 2015 issue of Regulation, Joseph Michael Newhard recounts the history of gun control legislation and contends that U.S. manufacturers have frequently benefited from gun control legislation that reduces their competition.

The 1968 Gun Control Act was no different. Limits were imposed on foreign imports and manufacturers, importers, and dealers were forced to be licensed, reducing the ability of individuals to sell firearms. Instead of a decline in firearms sales in the United States, the law simply transferred profits originally going to importers to manufacturers. As the Times reported on May 4, 1969, the Act,

which barred the importation of cheap, concealable-type handguns, is being defeated by the domestic manufacture of the guns or by the importation of foreign parts for assembly in this country….A domestic industry is thus blossoming to meet the brisk demand and will soon be turning out about 500,000 cheap pistols a year, compared to roughly 75,000 made here before the import restriction.

The recent Times article, however, ignores the role of gun manufacturers and the benefits the Act conferred to them. The article focuses on provisions that were ultimately left out of the act—namely, licensing and registration requirements—because of political pressure and lobbying by the NRA. The fact that provisions that directly benefited gun manufacturers survived political opposition and remained in the final bill is a testament to the power of bootleggers and Baptists.

Written with research assistance from David Kemp.

Why Doesn’t the Surgeon General Seek FDA Reclassification of Naloxone to OTC?

The Surgeon General issued an “Advisory on Naloxone and Opioid Overdose” today, drawing attention to the effectiveness of the opioid overdose antidote naloxone. The drug, approved for use since 1971, is an effective remedy that can be safely administered by lay personnel who receive basic instructions. The Advisory cites research demonstrating that community-based overdose education and naloxone distribution reduces overdose deaths, and points out that first responders in most states and communities are now equipped with the drug.

Because naloxone is available only by prescription, most states have developed workarounds to make it more available to patients and, in some cases, third parties who have proximity to medical and non-medical opioid users. This way, witnesses to an overdose can be capable of rescuing the victim. This usually involves a state authorizing pharmacists to prescribe the drug or, in many cases, the state health director, acting as the state’s physician, issuing a “standing order” to pharmacists to distribute it.

The Advisory lists a number of conditions and situations that might place a person at risk of opioid overdose and encourages such people, or people who know them, to avail themselves of naloxone. It supports efforts at wider distribution at the community level.

Unfortunately, because of the stigma that has developed in association with opioid use, many opioid patients are reluctant to speak to the pharmacist and request a naloxone prescription. In some states, the naloxone will not be prescribed to third parties who know an opioid user. Also, numerous instances have been reported where pharmacists are reluctant to prescribe the antidote, believing they are “enabling” a drug abuser.

Recognizing this obstacle to naloxone distribution, Australia made it available over-the-counter in 2016, making it as easy to purchase as cold remedies or antacids. This way medical and nonmedical opioid users can discreetly make a purchase and check out at the cash register without having to answer any questions or face scrutiny from a pharmacist. The drug has been over-the-counter in Italy for over 20 years.

Topics:

From Silicon Valley to the Big Apple: John Williams Named Next NY Fed President

The Federal Reserve Bank of New York has made its decision. On June 18 of this year John Williams, currently serving as the President of the Federal Reserve Bank of San Francisco, will succeed William Dudley as New York Fed President. This decision will have many ramifications in the years to come, but several key points immediately stand out.

It means that Jerome Powell, the newly minted chair of the Fed, who is a lawyer not an economist, will have someone steeped in monetary policy by his side on the Federal Open Market Committee (FOMC) — the NY Fed President serves as the vice chair of the FOMC and is a permanent voter.

Williams has spent nearly his entire career within the Federal Reserve System. A student of John Taylor, Williams earned his PhD in 1994 at Stanford and immediately went to work at the Board of Governors. He stayed at the Board until 2002 when he moved to the San Francisco Fed. In 2011, Williams succeeded Janet Yellen as president there, having served as her research director.

The move to NY continues Williams’ ascension through the ranks of the Fed. While the NY Fed is one of a dozen regional banks, it is far and away the most important.

As president of the San Francisco Fed, Williams was already a voter on this year’s FOMC, but leading the NY Fed gives him a vote every year — the San Francisco Fed President votes only once every three years.

With the trading desk housed at the NY Fed, it is responsible for executing the monetary policy decisions of the FOMC. The NY Fed’s special placement makes its president one of the top three officials within the Federal Reserve System — along with the Vice Chair of the Board and, of course, the Fed Chair.

While Williams has never worked directly in financial markets, that fact should not be seen as a criticism. His career in monetary policy complements Chair Powell’s business background, which is important as long as the Vice Chair of the Board remains a vacant seat. Furthermore, and perhaps because he has not worked directly in markets, Williams understands that monetary policy should not overreact to short term data, particularly drops in financial markets. In his most recent speech, he said that there is no reason to expect a “knee-jerk reaction” from the Fed in response to recent events.

Williams’ specific monetary policy expertise is important in additional ways.

The Emerging Graham-Cassidy 2.0 Proposal

Conservative groups including the Heritage Foundation are circulating a proposal that builds on legislation by Sens. Lindsay Graham (R-SC) and Bill Cassidy (R-LA) to overhaul ObamaCare. Even though I don’t know whether Graham and Cassidy have endorsed these updates, I will go ahead and call this proposal Graham-Cassidy 2.0. The proposal seems ill-advised, particularly since there is an alternative that is not only far superior in terms of policy, but also an easier political lift that would deliver more political benefit.

The key to evaluating any proposal to overhaul ObamaCare is to understand the law’s centerpiece is its pre-existing conditions provisions. Those provisions are actually a bundle of regulations, including a requirement that insurers offer coverage to all comers, restrictions on underwriting on the basis of age, an outright prohibition on underwriting on the basis of health, and a requirement that insurers treat different market segments as being part of a single risk pool. ObamaCare’s preexisting-conditions provisions have the unintended and harmful effect of penalizing high-quality coverage and rewarding low-quality coverage. ObamaCare contains other harmful regulations, but its preexisting-conditions provisions are by far the worst. Unless a proposal would repeal or completely free consumers from ObamaCare’s preexisting-conditions provisions, it is simply nibbling around the edges.

From what I have seen, Graham-Cassidy 2.0 nibbles around the edges.

To its credit, Graham-Cassidy 2.0 would zero-out funding for and repeal the entitlements to both ObamaCare’s premium-assistance tax credits (read: Exchange subsidies) and benefits under the Medicaid expansion. Unfortunately, it would not repeal that spending. Instead, it would take that money and send it to states in the form of block grants. The aggregate spending level for those block grants would grow more slowly over time than Exchange subsidies and federal Medicaid-expansion grants would under current law.

Limiting the growth of those spending streams seems like a better idea than letting them grow without limit, as current law allows. However, there is more downside than upside here.

First, Graham-Cassidy 2.0 would transform a purely federal spending stream into a intergovernmental transfer. At present, Exchange subsidies are payments the federal government makes to private insurance companies. Under Graham-Cassidy 2.0 (and 1.0), the feds would send those funds to states, which would use them to subsidize health insurance in various ways. Roping in a second layer of government diffuses responsibility and reduces accountability, regardless of whether the feds send those funds to states in the form of a block grant. Voters who don’t like how those funds are being spent would have difficulty knowing which level of government to blame, and whichever level of government is actually responsible could avoid accountability by blaming the other. Intergovernmental transfers are so inherently corrupting, there should be a constitutional amendment prohibiting them. And yet Graham-Cassidy 2.0 would substitute an intergovernmental transfer for spending with clearer lines of accountability.

Second, Graham-Cassidy 2.0 also diffuses accountability for ObamaCare’s preexisting-conditions provisions. Those provisions would continue to operate (with slight modifications). As a result, they would continue to destabilize the individual market, punish high-quality coverage, and reward low-quality coverage. The purpose of the Exchange subsidies is to mitigate that instability. Today, it is clear that Congress is responsible for any harm those provisions inflict, and the success or failure of the Exchange subsidies to mitigate those harms. Graham-Cassidy 2.0 would give that money to states and task them with mitigating those harms. When states fail to do so, as at least some states inevitably will, whom should voters blame? Congress, which started the fire? Or states, to whom Congress handed the fire extinguisher?

Third, while Graham-Cassidy 2.0 would eliminate two federal entitlements, eliminating entitlements is desirable only to the extent it limits government control over economic resources—in this case, spending. And while Graham-Cassidy 2.0 proposes to hold the growth of this repurposed ObamaCare spending below what it would be under current law, there is reason to doubt such a spending limitation would hold.

When examining the merits of any policy proposal, one must also consider the political dynamics the proposal would unleash. Generally speaking, states are a more politically powerful and sympathetic constituency than the current recipients of Exchange subsidies (private insurance companies). States have been able to use that political clout to get Congress to disregard the spending limits it imposed on SCHIP, for example, when so-called emergencies led states to blow through their initial allotments. Moreover, since Graham-Cassidy 2.0 would preserve ObamaCare’s preexisting-conditions provisions, it would come with its own built-in emergencies. As sure as the sun rises in the East, states will come to Congress and claim their block-grant allocations were insufficient to mitigate the resulting harms. Congress would be unlikely to say no—members rely on state officials for political support, after all—which means the spending restraints in Graham-Cassidy 2.0 are less than guaranteed.

Fourth, also pushing the direction of bigger government, Graham-Cassidy 2.0 would expand the constituency for ObamaCare spending. At present, the money the federal government spends on ObamaCare’s Medicaid expansion does not enjoy the support of the 19 states that have not implemented the expansion. The block grants in Graham-Cassidy 2.0, by contrast, would go to all states. As a result, non-expansion states like Texas would go from not caring about whether that federal spending continues to insisting that it does. At the same time, Graham-Cassidy 2.0 would expand the constituency of voters who want to preserve that spending. At present, able-bodied, childless adults in non-expansion states receive no benefit from ObamaCare’s Medicaid expansion or its Exchange subsidies. Graham-Cassidy 2.0 would allow (and in some cases require) states to provide subsidies to such adults below the poverty level, thereby creating another constituency that will reliably vote to expand those subsidies.

Fifth, a provision of Graham-Cassidy 2.0 that supporters consider a selling point would expand the constituency for more spending yet again. The proposal would require all states to allow all able-bodied, non-elderly Medicaid enrollees to use their Medicaid subsidy to purchase private insurance. Since greater choice would make Medicaid enrollment more valuable, and since roughly one third of people who are eligible for Medicaid are not enrolled, this would perversely lead to a large “woodwork effect,” where people who were previously eligible for Medicaid but not enrolled begin to enroll in the program. When Medicaid enrollment increases, so will Medicaid spending, and so will the population of voters who are willing to vote for higher Medicaid spending and the higher taxes required to finance it.

Since Graham-Cassidy 2.0 would preserve ObamaCare’s preexisting-conditions provisions, it is hard to see what would justify taking these one or two uncertain steps forward and multiple steps backward.

This is particularly true since there is a much better alternative on the table: strongly encouraging the Trump administration to allow insurers to offer short-term health insurance plans with renewal guarantees that protect enrollees from having their premiums increase because they got sick. Doing so would allow consumers to avoid all of ObamaCare’s unwanted regulatory costs, particularly those imposed by its preexisting-conditions provisions. The Trump administration can create this “freedom option” by administrative rulemaking—comments on the administrations proposed rule are due April 23—which is a much easier political lift than garnering 217 votes in the House and 51 votes in the Senate. Expanding short-term plans would also create salutary political dynamics that would force Democrats begin negotiating a permanent overhaul of ObamaCare.

As of today, Graham-Cassidy 2.0 just can’t compete with that cost-benefit ratio. Every ounce of energy spent on it, rather than on expanding short-term plans, is a waste.

South Dakota Is Taxing the Constitution

Despite over a century of Supreme Court decisions holding that a state cannot force wholly out-of-state entities to collect taxes for them, South Dakota wants to do just that. In 2017, South Dakota passed Senate Bill 106, which attempts to force out-of-state sellers that ship to South Dakota residents to collect and remit South Dakota’s sales tax. The law is in direct contravention to the 1992 case of Quill Corp. v. North Dakota, which held that states could not compel any entity to collect taxes unless the entity has a physical presence within the state. South Dakota sued Wayfair, a popular home goods vendor, among other retailers, in an attempt to enforce their law and overturn Quill in the process.

South Dakota’s law is at odds with the Constitution. Quill’s physical-presence requirement stemmed from decades of developments in tax law that struck an important balance between due process and the Commerce Clause of our Constitution. Due process requires some definite link—some minimum contacts—between the state and any person, property, or transaction that a state seeks to tax or regulate. Wayfair does not own property in South Dakota, elects no representatives in South Dakota, and was afforded no protection by South Dakota’s police. South Dakota’s only justification for binding a foreign entity to its law is that some of Wayfair’s many customers happen to live there. To allow South Dakota to compel Wayfair’s collection of its state taxes raises serious concerns of taxation without representation. If states can directly compel people who live outside state boundaries to adhere to state standards—standards the people had no chance to influence—the concept of statehood itself is undermined.

Cato has filed an amicus brief in support of Wayfair, because, as the Supreme Court once said, it is a “principle of universal application, recognized in all civilized states, that the statutes of one state have…no force or effect in another.” A federal constitutional structure inevitably poses difficulties like South Dakota is experiencing, especially where trade is flowing freely between states. South Dakota may have to think of other ways to raise revenue, but that is not a justification for undermining our constitutional structure. Governments around the world are prone to complain about the difficulties of collecting taxes, but our Constitution was not written to bend to the states’ desires to raise revenue.

Corruption in Virginia Government

As Washington Post readers know, there has been extensive corruption in the District of Columbia government for many years.

But D.C. is a city of 700,000 people within a metro area of 6.1 million. So I’ve been surprised about the relative dearth of news articles on corruption in the suburbs, particularly the Virginia suburbs.

Is that because there is: a) less corruption in VA, b) less media interest in covering it, or c) fewer auditors in VA digging for it?

Where there is government spending, there is corruption. There is a lot of federal, state, and local government spending in VA, so I’ve wondered whether “c” might be the right answer.

Well, how about that—the Post just reported on major corruption in VDOT:

During a snowstorm two years ago, Virginia Department of Transportation official Anthony Willie decided he should book a hotel room in Northern Virginia for the night. After all, he was in charge of snowplowing for the Burke area of Fairfax County.

While he was there, he wanted to have some fun. So he tried to get contractors and a co-worker to send women up to his room, according to court documents.

… Willie, of Culpeper, was sentenced this year to seven years in prison, having pleaded guilty to public corruption charges. He is among seven people convicted in a sweeping investigation.

Willie and his deputy, Kenneth Adams of Fairfax, demanded bribes from snowplow drivers in exchange for work. For six years they picked up payoffs at Outback Steakhouse and McDonald’s restaurants in the Washington suburbs. Along the way they increased their demands: Contractors said they were threatened when they balked at paying more.

… All seven defendants said in court that the corruption at the Virginia Department of Transportation is endemic to the culture and more extensive than the scheme that put them behind bars.

“It is happening now, it will happen in the future,” contractor John Williamson said before being sentenced to three months in jail. “It is rampant, and it is part of the culture of the agency.”

Prosecutor Samantha Bateman acknowledged in court that “this is a more pervasive problem in the Virginia Department of Transportation than is known.”

…Their crimes came to light only because another snowplow contractor complained to FBI agents looking into yet more alleged corruption at the agency involving falsified vehicle registrations. It is unclear where that investigation stands, but when FBI agents came to search Rolando Pineda Moran’s home, he told them they were missing the big picture.

“You’re looking at the trees. There’s a big forest out there,” Moran told them,

Adams also was selling cocaine — including to his boss, who was videotaped snorting the drug in his office, according to court documents. In addition to a public corruption charge, Adams pleaded guilty to possession with intent to distribute cocaine.

Both agency officials took between $200,000 and $300,000 in bribes, court documents said.

Isn’t that interesting? Corruption is alleged to be “rampant” and “endemic” in a major Virginia government agency, and the corruption has been apparently going on for years.

These crimes came to light because of a tip to federal investigators, who were investigating another different crime in VDOT.

Where were state auditors and investigators? And why has VDOT corruption festered so long?

Virginia has an Office of State Inspector General, which is supposed to investigate fraud, waste, and corruption in state agencies and contractors. Was this office aware of the alleged VDOT corruption? The Office does not post its investigative reports, and the last VDOT performance review in 2015 does not mention the problems.

Also, why is the FBI so involved in state and local public corruption? Look at this long list of public corruption investigations. Are the Feds doing work that state governments should be doing? Is federal help making the states helpless in policing themselves?